If there is one theme that has played out through this year, it has been the growing concern over corporate debt. The issue isn’t new. Some, like Credit Suisse, have been drawing attention to the large debt accumulated by certain corporate groups since 2012. Reserve Bank of India (RBI) governor, Raghuram Rajan, highlighted the problem almost as soon as he took over in 2014. However, the debate has widened and become shriller this year.
Regulators have taken a zero-tolerance approach towards errant corporate borrowers; the markets have punished these companies by beating down their stock prices; even banks are now beginning to realize that they can’t wish away the problem.
It’s only fitting then that the year ends with a warning from the central bank on rising corporate debt, backed by extensive analysis of how deep the debt problem really is.
The first takeaway from the study is that this isn’t an isolated problem that rests on the balance sheets of a few foolhardy corporate groups. The problem may be most extreme in some pockets, but it certainly isn’t restricted to a handful of firms.
Two data points are relevant in this context:
*A fifth of the listed non-government, non-financial companies are now categorised as leveraged. These are companies that have a negative net worth or a debt-equity ratio of more than two times. And 15% of these firms fall in the “highly leveraged" category. The proportion of both leveraged and highly leveraged companies has risen between September last year and this year.
*In the unlisted universe, data for which is only available till the end of the financial year 2014, about a quarter of the firms (both public limited and private limited) fell into a category defined as “weak". These are firms that have an interest coverage ratio of 1.
The second takeaway is that while the debt woes of large corporate borrowers get a bulk of the attention, smaller companies are also struggling.
The analysis of unlisted firms shows that leverage (or debt-equity) ratio among small companies has seen the steepest rise between fiscal 2012 and fiscal 2014. The debt servicing capabilities of these firms has also declined over this period. This is a segment of companies that does not have ready access to capital markets to raise funds nor the ability to withstand long periods of stress, which makes the trend a worrying one.
The third takeaway brings us back to the headline grabbing issue of large corporate debt, which has the biggest bearing on the country’s banking sector, purely because of the large size of borrowings. Here the RBI draws attention to the sharp jump in bad loans from this segment. Gross bad loans of large borrowers have jumped in a very short period of six months. Interestingly, all of this increase has come from public sector banks, which suggests that some of these banks had probably been delaying the recognition of these bad loans until this year.
Gross bad loans of large borrowers jumped from 6.1% in March 2015 to 8.1% in September 2015. The share of large borrowers in the overall gross bad debt of the banking sector also jumped from under 1% in March to 3.1% in September. Restructured loans in the large corporate segment are at about 8.6% of total outstanding loans to the segment.
Individually and collectively, each of these takeaways is concerning, which explains why the RBI governor chose to highlight the issue in his foreword to the Financial Stability Report released on Wednesday. Writing about the need to prepare for emerging risks, he lists corporate sector vulnerabilities at the top. “Corporate sector vulnerabilities and the impact of their weak balance sheets on the financial system need closer monitoring," Rajan wrote.
The question that remains unanswered is how these vulnerabilities will get addressed.
For the large corporate segment, the most likely answer lies in asset sales. Such sales from distressed firms have certainly picked up in the past year but given that a number of these firms operate in sectors like iron and steel, infrastructure and power, finding buyers has not been easy. Banks that have taken over stressed assets under strategic restructuring schemes will face the same problem.
These firms should also be looking to raise equity capital to retire some of their debt, something we haven’t seen much of. At a recent conclave of merchant bankers, the Securities and Exchange Board of India (Sebi) chief, U.K. Sinha, asked merchant bankers to work closely with leveraged firms to find ways to bring down debt levels.
For smaller firms, the best case scenario is a pick-up in demand in the economy, which will eventually revive earnings and improve their ability to service and repay their debt.
The bigger question to ask going into 2016 and beyond, is whether this overhang of debt will prevent fresh corporate investments. The availability of capital and lower interest rates is no longer the issue. The willingness of companies to pick up that capital and take on new risks is.
Ira Dugal is assistant managing editor, Mint